3.3 The macroeconomic environment for
investment

a) The planning system

During the 1960s and 1970s, Syria became a centrally planned
economy. While certain private companies, established much before, remained in
operation, most key aspects of the economy were firmly in the hands of the
State. The main sector that remained private was farming, but even
micro-economic farming decisions, in a wide variety of strategic
crops, were dependent on the local implementation of national production plans.
Farmers were assigned short-term credit in cash and kind, enabling them to plant
specified amounts of land with specified crops, and the product was to be sold
to specific state companies for processing and marketing. Most of these
regulations have been gradually relaxed since the economic crisis of the early
1980s, and especially during the 1990s, but some still remain in
place.

All investment projects that look for the benefits granted
under Law No.10 must be authorized by the concerned Ministries, certifying that
they are in agreement with the National Development Plan. This is often a
formality, but in some cases authorization has been delayed or denied because
the new project somehow was perceived as unwanted competition for state-owned
companies.

The most important and relevant impact of the planning system
on private investment is the fact that a large portion of the economic activity
has been for many years under strict planning and reserved to the state sector,
thus in effect precluding any private investment. Many such restricted sectors
still exist at the moment, including purchasing, processing and marketing
strategic crops, which directly affects agribusiness. For instance, a cereal
milling company can only operate as an outsource for the state company that has
a monopoly of milling operations.

Another very important impact is that most prices are based on
compulsory or indicative official prices set by the public sector. Even the
indicative prices are in effect almost compulsory because many traders, farmers
or other agents take them as their base price and do not alter them easily or
very often. Apart from being fixed and sometimes involving an implicit tax or
subsidy, the official prices are usually the same for all varieties and
qualities of the product, and thus do not permit the development of finer
grading of the products or the establishment of much-needed standards of
quality. Insofar as the rigid price system is in place, little can be done to
develop in Syria a more adequate system of quality standards and thus help
introduce Syrian products in world markets. Under the present system, such
improvements are to be introduced by the companies themselves on a one-by-one
basis, and they often cannot obtain raw materials of the required quality
because the price system is not discriminative enough to reward higher quality
with a higher price.

Also, even for prices that are theoretically free,
authorization must be sought from the government to change the price of the
product (either to raise it or to lower it). The license to adjust prices is
presently granted easily, but it could in theory be denied. Many companies
resort to special promotion or special discount schemes
to sidestep the requirement of governmental authorization for price
decisions.

b) The monetary and banking systems

The banking system in Syria is still characterised by features
fairly different from those generally found in market economies. Its most
salient characteristic is its public ownership. Despite the recent introduction
of legislation to allow for private banks, until the time of writing the entire
banking system is state-owned. The present condition of the state-owned banks is
unsuitable to serve as a conduit of private business. Much is to be done to
improve the efficiency of the public-sector banks, if they are to have any
participation in fulfilling the financial needs of the private sector.

Besides, much of banking credit is taken by the public sector.
The share of private borrowers on total credit has been increasing, but still
now more than two-thirds of the available funds are allocated to the public
sector. Most public corporations borrow from the Commercial Bank of Syria. More
than 90 percent of credit to the public sector, and nearly two-thirds of total
credit, goes to the state-owned organizations in charge of purchasing and
marketing cereals and cotton. Thus, in effect, the intervention of the public
sector to control and subsidize strategic crops creates a crowding-out effect in
the entire financial system.

Interest rates are administratively set by the Government and
have remained unchanged for years, in spite of changing levels of inflation. In
fact, the decline in inflation and the period of deflation in recent times meant
that real interest rates have gone up. The lending rates for private sector
borrowing are 7.5 percent to 9 percent, which, for instance, in 1999 implied a
real rate of 9.6 percent to 11.1 percent, given a deflation rate of 2.1 percent
(consumer prices).

Spreads between active and passive rates are small, about 1
percent, meaning that banks cannot adequately cover their operation costs, which
are difficult to assess precisely but should be higher than that small spread.
This is a further factor reducing the banks' ability to improve their
administrative efficiency. Apart from detracting from the banks' profitability
and requiring support from the public budget to keep the banks functioning, much
of the real consequences of this deficit in covering administrative costs is
borne by customers in the form of delays and difficulties in banking operations,
and acts as a drag in the overall efficiency of the economic system.

Besides the authorization for private banks to operate, other
reforms are pending regarding monetary policy and foreign exchange. The most
significant one is an adequate and updated legislation about Central Bank
functions and autonomy, and most crucially about bank oversight and regulation.
More adequate and transparent norms and practices to conduct monetary policy are
also still absent.

c) The foreign exchange system

Foreign exchangehas been tightly regulated for
decades. Holding or exchanging foreign currency has been considered a crime
punishable with prison. Liberalization of the foreign exchange market has also
been gradually taking place, but it still remains partial and the procedures
cumbersome. Holding foreign currency is no longer a crime, but dealing in
foreign currency is still punishable with prison. In particular, private
companies have no legal access to foreign currency unless they bring it from
abroad or buy it at the export proceedings market. This has been a problem for
companies that cater to the domestic market, especially when the export
proceedings market had a rate of exchange below the rate applicable for imports
(this problem have been recently made less relevant as the gap between the two
rates narrowed). In 2001 the Commercial Bank of Syria was authorized to buy and
sell foreign currency at market rates for personal (mostly tourism and
remittance) purposes, but not yet for business purposes.

Thus the overall economic environment in which private
investors operate has been changing in the direction of a more liberal system
during the last ten years or more. But many features of the old centrally
planned, state-led system remain in place. A decision to create a stock market
was taken nine years ago, but it has not yet been implemented. Procedures
related to business and trade remain complicated and uncertain, which creates
many delays and difficulties, and creates incentives to proceed through informal
channels when possible. The general picture is of a very rigid system on its way
to gradually becoming friendlier to private investment. However, the process of
liberalization has not proceeded at a constant pace. The liberalization process
that started in 1991 with the investment law and other measures, has not
advanced at a steady pace. Measures have been adopted piecemeal, with advances
in one area checked by failure to advance in others. After a decade, several key
pieces of economic reform are still pending. As a result, private investment has
been largely dependent on the short-term incentives given by the Investment Law,
and not on long-term growth expectations based on a stable set of rules of the
game.